Buy Now Pay Later…but can they afford to?

Following the launch in the UK of firms such as Klarna (in 2016) and Clearpay (in 2019), the popularity of buy now pay later (BNPL) has increased dramatically. With the coronavirus pandemic causing uncertainty for many, use of BNPL products have surged once again, with total sales of £2.7 billion across five million customers.

The services are typically offered through major retailers and allows the consumer to split or defer payments for up to 30 days at point of sale with no additional interest.

The products themselves have proved particularly popular with younger shoppers, especially in the online fast fashion market, as they offer a cheap and effective way of trying before you buy. As a result of this, the average value per transaction is relatively low and itself may seem relatively uncomplicated to manage. The concern raised by the Financial Conduct Authority (FCA) is that these types of transactions typically fall under the radar as they are not generally reported as debt to the Credit Reference Agencies (CRA). This raises additional concerns that these initially low value loans can quickly grow to unseen debts and act as a gateway to problem debts; findings by the FCA suggest that one in 10 people using BNPL services have already got debt arrears elsewhere[1].

As part of the review and recommendations laid out by the FCA, all BNPL providers should undertake affordability checks before offering credit to ensure customers are able to make the repayments.

Assessing the customer’s affordability as a condition for lending has become a well-established practice within the financial world, with both Secured and Unsecured lending markets having gone through significant changes over the past decade. Whilst some credit providers may be initially unreceptive to such changes a successful implementation of an effective affordability strategy will enable the lender to understand the customer’s true creditworthiness by incorporating both their ability (affordability) and willingness (credit risk) to repay the loan.

Affordability models are typically built based on a customer’s known income and outgoings. This may be complemented by additional modelling on household expenditure, usually based on data provided by the ONS, to give a holistic view of the customers affordability. However, given the profile of the typical BNPL customer, the traditional approach to modelling of household expenditure may not be appropriate. With 25% of customers under the age of 25, the debtor is more likely to be a member of a household unit and may have less responsibility for the overall outgoings. Alternative approaches to affordability modelling are therefore likely to be required, such as use of transactional data available via Open Banking, to give a true understanding of a BNPL customer’s affordability.

As a younger person’s income and expenditure profiles are likely to be significantly different from the wider population; whether its income capture via student loans or expenditure covered via rental/general board agreements.  Additionally, the younger generation is more likely to give consent to the use of open banking as digital banking is far more engrained within this demographic. A position reflected by the boom in the BNPL market itself.

[1] The Woolard Review – A review of change and innovation in the unsecured credit market (fca.org.uk)

ANY QUESTIONS ON AFFORDABILITY MODELS OR OPEN BANKING AND THE USE WITHIN RISK STRATEGIES, CONTACT TORGUNN AT TORGUNN.RINGSJO@4-MOST.CO.UK